How to Develop anOrganization Pay Policy

Use this guide to develop an organization pay policy for decisions that set competitive and reasonable pay ranges for each job in the organization as they relate to salary structures. In the process of evaluating different pay strategies, consider which may be appropriate in the context of your total rewards strategy and how they can affect your business performance.

The organization’s strategy toward the labor market requires a salary-level policy decision which involves determining how competitive the organization wishes to be. There are three common organization pay policies:

TYPES

1

LAG THE MARKET LEAD-LAG LEAD THE MARKET

In this strategy, update the salary survey data to the current date and then apply the new salary structure.

If a change in the labor market of 10% is assumed for the next year, then the only time the organization will be competitive with the market is at the beginning of the year.

By the end of the year, any decisions based upon the salary structure will be 10% behind the market.

In this strategy, the organization wishes to pay above the market rates.

Start the year at 10% above the wage survey data.

By the end of the year, the organization will be paying the market rate.

Here the organization takes account of the 10% estimated change in the market but wishes to be on average with the market.

You can do this by starting the year at 5% above the market rate.

Provided the increase is steady over the year, this strategy will place the organization ahead of the market in the first half of the year and behind it in the second half.

2

These three approaches are illustrated below:

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In order to determine the appropriate organization pay policy, you must establish the pay policy line. This is developed based upon a holistic, current state assessment of internal factors (such as current pay rates and job relationships) and external factors (such as labor markets, industry trends and laws).

Start by evaluating all jobs in the organization. Determine which jobs represent most of the total labor costs, since policy changes that directly affect these jobs significantly impact the bottom line and largely determine the competitive salary level of the firm. Salary relationships are built around these labor costs. See “How to Conduct Job Evaluations.”

INPUTS

INTERNAL JOB RELATIONSHIPS

Internal JobRelationships

CurrentMarket Rate

PayPolicy Line

Once the jobs are evaluated, market rates are relied upon to determine the competitiveness of the current salary levels in the organization. This means the use of salary surveys. Here is an example of market rates for commercial banking jobs in the Tallahassee, Florida, labor market:

Now you can define a pay-policy line by plotting points reflecting the jobs in your organizations based on two dimensions: compensation value and a job ranking (or job evaluation result). Then you “fit” a sloped line from the lowest value to the highest value using one of three methods:

The method you use will depend on the budget and resources (time and talent) allocatedto compensation analytics processes in your organization.

• Low-high

• Freehand

• Least-squares

Reviewing the Loan Processor market rates, the 10th, 25th, survey mean, 75th and 90th percentiles are displayed. The actual salary is also entered to calculate the market index, in this case, 91%. That is, the Loan Processor internal salary rate of $34,480 is 9% lower than the market rate.

CURRENT MARKET RATES

PAY-POLICY LINE

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Low-high line: This is a straight line connecting the highest and the lowest of the plotted points (often called anchor points). The rates of all intervening jobs are made to fall on the line. Below is an example of a low-high line.

Freehand line: After you plot the points, you can often easily visualize the trend of the data. In this case, it is possible for you to draw a freehand line that best describes the plotted points. In drawing such a line, follow the principle that vertical deviations from the line are minimized if the line follows the obvious slope of the data. Although the line may be curved, a straight line has the advantages of being easy to plot and simple to explain. Below is an example of a freehand straight line.

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POINTS

PAY GRADES

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RATES

LOW-HIGH LINE

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SALARY

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PAY GRADES

FREEHAND STRAIGHT LINE

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Least-squares line: The least-squares line mathematically minimizes the overall vertical distance from the points to the line. Spreadsheets and other software can automatically add such trend lines, or the slope and intercept of the least-squares can be calculated from the points and the resulting line plotted.

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SALARY

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POINTS

PAY GRADES

LEAST SQUARES LINE

For those organizations with limited resources, a low-high (anchor-point) line or a freehand line may achieve sufficient accuracy in developing a pay policy line that will serve as input to a competitive pay strategy. Depending on the organization culture, however, HR practitioners may prefer a salary line calculated by least-squares.

By evaluating the pay policy line relative to overall total rewards strategy, you can establish an organization pay policy which evaluates any salary differentials, and their relative business impact, which vary.

WHICH LINE SHOULD YOU USE?

BUSINESS IMPACT

ERI’S ASSESSOR SERIES

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GeographicAssessor

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ABOUT ERI ECONOMIC RESEARCH INSTITUTEERI Economic Research Institute has been trusted for decades to provide compensation survey data. We compile the most robust salary survey, cost-of-living, executive compensation, and job competency data available. Thousands of corporate subscribers, including the majority of the Fortune 500®, rely on ERI analytics to streamline the compensation planning process, develop compensation packages that attract and retain top performers, and provide defensible data that holds up during litigation and audit.

• Low-salary organizations may experience greater differentials.

• Organizations employing largely semi-skilled workers and promoting from within have smaller differentials than organizations employing many highly skilled workers who

must be hired from the outside.

• If there is high unemployment in the local labor market, there will be smaller differentials between market rates and evaluated rates, even in low-salary

organizations.

• Geographically isolated organizations or those with large numbers of unique jobs experience less conflict.

7

Organizations will generally have some intended and/or unintended salary differentials with market rates. A common approach is for an organization to minimize differentials by paying at or above the market for strategic core competency jobs that drive competitive advantage, while paying the non-strategic jobs at or below market rates, requiring separate pay policy lines for each category of jobs.

Consider the varying business impact in these scenarios:

This guide has provided a framework to develop a competitive pay strategy relative to overall total rewards and HR strategy. Organizations looking to compete effectively need to keep their HR and related programs aligned with business objectives. For more information on this and related topics, visit www.erieri.com or call 1-800-627-3697.

SUMMARY